From the editors: This piece by Triple Crisis blogger Kevin Gallagher appeared previously on the Institute for New Economic Thinking blog.
World leaders who are gathering for the APEC summit next week had hoped to be signing the Trans-Pacific Partnership Agreement (TPP). The pact would bring together key Pacific-rim countries into a trading bloc that the United States hopes could counter China’s growing influence in the region.
But talks remain stalled. Among other sticking points, the U.S. is insisting that its TPP trading partners dismantle regulations for cross-border finance. Many TPP nations will have none of it, and for good reason. The U.S. stands on the wrong side of experience, economic theory, and guidelines issued by the International Monetary Fund.
Indeed, it’s the U.S. that could learn a few lessons from the TPP countries when it comes to overseeing cross-border finance.
As Katherine Soverel and I show in a new report with Chilean economist Ricardo Ffrench-Davis and Malaysian economist Mah-Hui Lim, TPP nations such as Chile and Malaysia successfully regulated cross-border finance to prevent and mitigate severe financial crises in the 1990s.
In the wake of financial crisis of 2008, there has been a global rethink regarding the extent to which cross-border financial flows should be regulated. Many nations, such as Brazil and South Korea, have built on the example of Chile and Malaysia and reregulated cross-border finance through taxes on short-term debt and foreign exchange derivative regulations. After the global financial disaster of 2008, emerging markets and developing nations want as many tools as possible to prevent and mitigate crises.
New research in economic theory justifies this. Anton Korinek and Olivier Jeanne have demonstrated how cross-border financial flows generate externalities because investors and borrowers do not know (or ignore) the effects of their financial decisions on the financial stability of a particular nation. Foreign investors may well tip a nation into financial difficulties, and even a crisis. Korinek and Jeanne argue that regulating cross-border finance will correct for the market failure and make markets work more efficiently.
Such thinking has helped trigger an about face at the IMF on capital flows. Last December, the IMF endorsed an “institutional view” on capital account liberalization and the management of capital flows. The IMF now recognizes that capital flows bring risk, particularly in the form of capital inflow surges and sudden stops, which can cause a great deal of financial instability. Under such conditions, the IMF will now recommend the use of cross-border financial regulations to avoid such instability.
I led a task force on regulating global capital flows that examined the extent to which the regulation of cross-border finance was compatible with many of the trade and investment treaties across the globe. The task force consisted of former and current central bank officials, IMF and WTO staff, members of the Chinese Academy of Social Sciences, scholars, and other members of civil society. In a report published this year, we found that U.S. trade and investment treaties were the most incompatible with new thinking and policy on regulating global finance.
Not only do U.S. treaties mandate that all forms of finance move across borders freely and without delay, but deals such as the TPP also would allow private investors to directly file claims against governments that regulate them, as opposed to a WTO-like system where nation states (i.e., the regulators) decide whether claims are brought. Therefore, under investor-state dispute settlement a few financial firms would have the power to externalize the costs of financial instability to the broader public while profiting from awards in private tribunals.
Such provisions fly in the face of recommendations on investment from a group of more than 250 U.S. and globally renowned economists in 2011. The 2012 IMF decision echoed these sentiments, saying, “These agreements in many cases do not provide appropriate safeguards or proper sequencing of liberalization, and could thus benefit from reform to include these protections”.
Emerging market and developing countries should refrain from taking on new trade and investment commitments unless they properly safeguard the use of cross-border financial regulations. Leaked text of the TPP reveals that Chile and other nations have proposed language that could provide such safeguards. The U.S. should work with those nations to devise an approach that gives all nations the tools they need to prevent and mitigate financial crises.
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